Less boom perhaps, but no gloom ahead

The property market may be cooling, but Australia's economy remains strong.

The Australian economy's considerable strengths were on display again in 2003. Compared with previous years, overall growth was relatively subdued: the drought, geopolitical tensions centred on the Iraq war and the SARS epidemic in Asia hit an already weak global economy to produce what Treasurer Peter Costello called the toughest trading conditions in years. Still, the economy expanded by 2.2 per cent in the year to June and by 2.6 per cent in the year to September, below the 4 per cent clip it has been achieving in recent years, but enough to continue what is now a record period of growth. It has been 49 quarters since the economy contracted for two consecutive quarters, the traditional definition of a recession.

The outlook is for continued growth next year, but the drivers of growth are changing. Export volumes have declined in the past two years, for the first time since the 1950s. But domestic consumption has been exceptionally strong, and one of its key drivers has been the residential housing boom. The Reserve Bank is now lifting interest rates, and there are clear signs that the housing boom is slowing. That and the rate rise that is prompting it will brake the domestic economy in 2004. At the same time, however, the global outlook is improving.

The SARS virus has been beaten back, and two-way trade between Australian and Asia, including tourism, is recovering. There is no guarantee that SARS will not re-emerge, but health authorities everywhere will be much better prepared for it if it does. Solid rain appears to have broken the back of the drought, and while the ultimate repercussions of America's military victory in Iraq are still unclear, the instability in oil and other critical world markets that accompanied the build-up to war in Iraq has moderated.

Most importantly, the outlook for global growth has improved. After being balanced on a knife edge in 2002 and the first half of 2003, the US economy is now gaining momentum. Japan's economy is producing its most encouraging signs in a decade, and the European economy is also accelerating. The economic recovery overseas is boosting demand for the things Australia sells, and in that respect Australia's traditional strengths in the resources and agricultural commodity sectors are being underlined. During the internet sharemarket bubble of the 1990s, there were fears that Australia had become a mere spectator in a transforming event, the internet revolution. But with the bubble broken, the internet is seen for what it mainly is: new technology that offers productivity gains to existing enterprises rather than rendering them redundant. Australia still needs to step up its engagement with these new technologies. But its role as a key raw supplier to the world is still central to its long-term economic performance.

The economy is expected to post growth of about 3.5 per cent next year, giving it a chance of continuing to lower the unemployment rate, which eased from 6.2 per cent in March to 5.6 per cent in November. It could do so without adding significantly to inflation, which is running moderately, at 2.6 per cent in the year to September. Not surprisingly given this outlook, confidence is high and businesses are investing strongly. There are still issues for business arising from the '90s boom. In 2004 the courts will, for example, continue the lengthy process of cleaning up after the excesses that accompanied it. And there is lingering anger in the community about poor corporate governance during the '90s boom and about high payouts for executives, even when they have failed. It is, however, clear now that while Australia did not totally escape the corporate excesses of the boom, it was caught less squarely by them than other countries, notably the United States. Australia's less pedantic corporate law system coped reasonably well with the boom, and has been strengthened significantly in response to the governance breakdowns that were detected.

There are two important caveats to this generally sanguine economic and business outlook. The first is the dollar, which has surged by almost 31 per cent this year, from just over 56 US cents to more than 73. At this level the currency is more than fully valued, and it is blunting the gains that global recovery in demand offers. Further rises would significantly pressure Australia's export performance, but it is fact that the issue is largely out of the hands of the authorities, who allowed the dollar to float 20 year ago. The reality is that our dollar's rise is a mirror of the American dollar's fall this year, and if the US dollar continues to slide, Australia's exporters will come under even greater pressure. The second caveat applies to the housing sector. The extent and nature of household exposure to speculative residential property, most of it inner-city apartments, and the vulnerability of those exposed to rises in interest rates is, at this stage, not well understood. Also, there is no guarantee that the rate rises that began in November and will probably continue in the first half of 2004 will not trigger a serious residential property price crash and a wave of debt defaults that drag down the economy.

There are, however, reasons to hope that the currency and residential property markets will behave. Capital will flow into the US as its economic recovery matures, and the accelerating economy will, at some stage this year, push rates higher in that country, something that will make the Australian dollar and the relatively high interest rates on offer here less attractive. And a crash in parts of the residential market would mostly affect individuals and would therefore probably be less traumatic than the commercial property crash of the early '90s, which quickly lengthened the unemployment queues by pressuring financially over-extended companies, including the banks.